The Rust Belt Didn't Adapt And It Paid The Price

In 11 days Donald Trump will be sworn in as the 45th President of the United States. His victory in the 2016 election was a surprise to many, and his success in the so called Rust Belt made it happen. Wisconsin, Michigan and Pennsylvania all went to Trump, something that hadn’t happened for a Republican candidate since Ronald Reagan in 1984.

Many of the voters in these states, especially those without college degrees, feel like economic opportunity is vanishing and the region’s population loss reflects that. The graph below shows the proportion of the country’s population that resided in Wisconsin, Illinois, Indiana, Michigan, Ohio, West Virginia, Pennsylvania and New York from 1950 to 2000. The orange line removes the population of New York City since it is not part of the Rust Belt in the same way that Buffalo and western New York are and unlike similar cities (e.g. Philadelphia) its population is such a large part of its state.

Source: U.S. Census data and author's calculations.

In 1950 the Rust Belt including New York City contained over 38% of the country’s population and without it 33%. By 2000 the Rust-Belt’s share had fallen to 28% and 25% respectively.

Some of these causes, like weather or geography, cannot be altered. Others are under the control of politicians, residents and firms. For example, every state in the Southeast is a right-to-work state, a policy that has been associated with more manufacturing activity, while only four of eight Rust-Belt states—Wisconsin, Indiana, Michigan and West Virginia—have adopted similar laws.

But this doesn’t tell the whole story. The four Rust-Belt states with right-to-work laws didn’t start implementing them until 2012, while most of the Southeastern states have had the laws in place since the 1950s. This means Rust-Belt states have had a relatively unfavorable economic policy in place for at least the last 50 years. At this point, if Ohio, Illinois, Pennsylvania or New York ever adopt a right-to-work law they will merely be keeping pace.

There is also evidence that the private employers and unions in the Rust Belt states contributed to the area’s economic decline. First, there was a general lack of competition in Rust-Belt industries such as steel, tires and automobiles in the decades following World War II. Each industry was dominated by a few domestic firms like U.S. Steel and General Motors (GM) and faced little foreign competition due to the destruction caused by the war. Since there was enough business to go around, firms felt little pressure to innovate or increase productivity.

This reality was even recognized by the industries themselves. Alder et al. (2014) reprint a quote from the 1980 annual report of the American Iron and Steel Institute, which represented the large U.S. steel manufacturers:

In addition to the lack of competition for the products themselves, there was also a lack of competition in the region’s labor market. Two of the largest and most powerful unions in the country were based in the Rust Belt: the United Steelworkers (USW) and the United Auto Workers (UAW). These two unions were able to use the threat of widespread strikes to obtain higher wages, which increased production costs for Rust-Belt firms.

This relationship can be seen in the figures below. The left shows the number of work stoppages involving over 1,000 workers per year from 1950 to 2000. The right shows the Rust Belt wage premium for manufacturing workers from 1950 to 2000.

Source: Alder, Simeon, David Lagakos, and Lee Ohanian. Competitive pressure and the decline of the Rust Belt: A macroeconomic analysis. No. w20538. National Bureau of Economic Research, 2014.

The number of work stoppages is a proxy for union power and as shown in the figure the Rust-Belt wage premium declines congruently with union power. Taking into account things like education and work experience (red line, right figure), manufacturing workers in the Rust Belt made about 13% more than similar workers in other regions from 1950 to 1980. As union power declined, this wage premium—and firms’ costs—declined along with it.

The power of unions contributed to the lack of innovation and productivity improvements via what economists call a “hold up” problem. Firms bear the full cost of innovation and they know that any increase in profits due to productivity improvements will have to be bargained over with the unions. This makes them reluctant to invest, since they know unions will try to capture as large a share of the new profits as possible. After 1980 the “hold up” problem subsided as union power diminished.

Alder et al. calculate that the lack of competition in both the output and labor markets of Rust-Belt industries can account for most of the decline in the region’s share of employment from 1950 to 2000.

Unfortunately, by the time union power subsided and both workers and firms realized that they had fallen behind new foreign and domestic competitors it was too late. This result shouldn’t be surprising, as economist Joseph Schumpeter explained what happens to firms who fail to innovate in the face of competition back in 1942:

…the competition from the new commodity, the new technology, the new type of supply, the new organization….competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of existing firms but at their foundations and their very lives.

American steel and automobile companies are not what they used to be and without the 2009 auto bailout two of the “Big Three” car companies—GM and Chrysler—might not exist.

The people of the Rust Belt are disappointed with the American economy—and there are many policies not to like. Our tax code is a mess, economic freedom is declining and occupational licensing and zoning restrictions prevent people from getting better jobs and moving to better places. The first two are largely federal-level problems, but the last two, along with other sensible state-level reforms, are within the purview of Rust-Belt residents themselves. Thus, as with most things, some of the blame lies within.